Delaware Court Addresses Freeze-Out Merger Confronted with Topping Bid

Delaware Court Addresses Freeze-Out Merger Confronted with Topping Bid

The Delaware Court of Chancery addressed an unusual situation where a third-party interloper submitted a topping bid over a controlling stockholder’s freeze-out merger that would have provided significantly more value to the minority stockholders. The controlling stockholder refused to sell its stake or otherwise agree to the third party’s terms, and the company’s special committee thus proceeded with its recommendation of the freeze-out merger. The court dismissed a minority stockholder’s complaint that sought to impose “entire fairness” review on the transaction. The court found that the special committee was independent and discharged its duty of care and that the minority stockholders were not coerced by the controller’s refusal to support a third-party deal.

Background

Smart Local Unions and Councils Pension Fund v. BridgeBio Pharma, Inc., stemmed from a controlling stockholder’s 2021 take-private of Eidos Therapeutics, Inc., a publicly-traded, development-stage biopharmaceutical company.¹ Prior to the freeze-out negotiations, a global pharmaceutical company approached the company about collaborating in the development of one of the company’s drugs. Eidos’s board of directors rejected the proposal. Several weeks later, Eidos’s controlling stockholder proposed a go-private transaction that was conditioned on approval by (i) a special committee of independent directors and (ii) a majority of the minority stockholders. During negotiations with the special committee, the controlling stockholder indicated it was not interested in selling its stake in the company, and the special committee thus concluded it would be pointless to solicit third-party interest. After several months of negotiations, the parties entered into a definitive merger agreement with the special committee’s approval and recommendation.

After the merger agreement was announced, the third-party pharmaceutical company which had previously expressed interest in a collaboration contacted the controlling stockholder and the special committee to submit a competing proposal that represented an approximately 63% premium over the per share consideration offered to the minority stockholders in the freeze-out.  The third-party pharmaceutical company also indicated that if the controller was unwilling to sell its stake, it would be willing to acquire only the minority interest provided that the controller agreed to certain governance protections for the third party going forward, including board representation, anti-dilution protection, information rights, and approval rights over certain business decisions. Over the controller’s objection, the special committee concluded that the proposal was reasonably likely to be a superior proposal and entered into discussions with the third party.

During the discussions and despite the fact that the third party said it might be able to raise its purchase price, the controlling stockholder remained steadfast that it was not a seller and rejected the third party’s proposals. Because the special committee lacked the ability to compel the controller to accept the third party’s proposals, it maintained its recommendation to the minority stockholders that they approve the freeze-out merger. The third party’s transaction proposal was disclosed in the proxy statement, and approximately 80% of the minority shareholders approved the freeze-out and it was completed.

Plaintiff’s Arguments

The controller structured the transaction under Kahn v. M&F Worldwide to obtain the protections of the business judgment rule.² The plaintiff, however, alleged that the transaction did not comply with M&F Worldwide because, among other things, the special committee had not discharged its duties in dealing with the topping bid and the minority stockholders were coerced into accepting the freeze-out merger’s lower consideration. The plaintiff also argued that the business judgment rule should not be applied when there is a third-party topping bid offering superior value to a controller’s offer.

Court’s Opinion

The court rejected plaintiff’s argument that M&F Worldwide should not apply in the context of a topping bid. The court then found that the controller was not under any legal obligation to sell its interest or negotiate new terms of control to facilitate the third party’s purchase of the minority stockholders’ interests. The court further found that the special committee had appropriate authority to consider the transaction and “veto” the freeze-out merger and fulfill its duty of care, including through 24 meetings over four months (including 9 meetings following the announcement of the merger and topping bid), encouraging the controller to engage with the third party, and pressing the controller to reconsider its stated unwillingness to sell. “That [the third party’s] acquisition proposals reflected a substantial premium over the merger price,” the court reasoned, “does not establish a lack of due care” by the special committee.³

The court also held that the complaint failed to allege that the controller “inserted itself or altered the Special Committee’s powers.”⁴ In addition, the court rejected numerous disclosure claims relating to the process and the topping bid, including challenges to the company’s description of the third party or its initial collaboration proposal. Lastly, the court held that the minority stockholders were not coerced into approving the freeze-out merger even though the alternative was to remain a controlled company. The court contrasted other situations where coercion was found, noting, for example, that Eidos was not financially distressed or facing a delisting which might be more indicative of coercion. 

Take-Aways

It is unusual for a freeze-out merger to be challenged by a third-party topping bid. When it does occur, it can be challenging for independent directors for several reasons – including the inability to seize a higher per share purchase price for the minority stockholders or to force the controller to deal with the third party. Established Delaware law, however, holds that controlling stockholders are not obligated to sell or divest control just because it would benefit the minority stockholders.⁵

Although the court did not cite to the case, Mendel v. Carroll presented a similar fact pattern where a third party made a proposal that offered a higher per share price to minority stockholders.⁶ The court recognized the unique issues associated with corporate control in this context, including the fact that the controller is not required to share its control premium. While Mendel noted that the board still had a duty to protect the minority stockholders in a transaction with the controller, BridgeBio held that the business judgment rule can still apply under M&F Worldwide.

It is also noteworthy that the controlling stockholder’s effective veto over a third-party proposal did not render the freeze-out coercive. Otherwise, coercion could be alleged in almost any controller situation. This result is consistent with Orman v. Cullman,⁷ another important case not cited by BridgeBio even though it presented similar issues. There, the controller supported a third-party sale that was conditioned on approval of the minority stockholders. To induce the buyer, the controller entered into a voting agreement in which it agreed to support the sale and not approve any other transactions for 18 months. The court rejected the plaintiff’s argument that the voting agreement was coercive. While there was no evidence of other potential proposals, the court also focused on the fact that a minority stockholder is not inherently coerced by virtue of a controller’s control. The court reasoned that, “[u]nless being in a voting minority automatically means that the shareholder is coerced (because the minority shareholder’s investment views or hopes have been precluded by a majority), plaintiff’s concept of coercion is far more expansive than Omnicare or any other decisional authority brought to my attention.”
 

¹ C.A. No. 2021-1030-PAF, mem. op. (Del. Ch. Dec. 29, 2022).

² Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014).  Under this case, a freeze-out merger will be reviewed under the deferential business judgment rule instead of entire fairness if (i) the controller conditions the procession of the transaction on the approval of both a special committee and a majority of the minority stockholders; (ii) the special committee is independent; (iii) the special committee is empowered to freely select its own advisors and to say “no” definitively; (iv) the special committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.

³ Id. at 38.

⁴ Id. at 38.

⁵ See, e.g., Bershad v. Curtiss-Wright Corporation, 535 A.2d 840, 845 (Del. 1987). (holding that “a majority stockholder is under no duty to sell its holdings in a corporation, even if it is a majority shareholder, merely because the sale would profit the minority”); Peter Schoenfeld Asset Management, LLC v. Shaw, 2003 Del. Ch. LEXIS 79, *9 (Del.Ch. July 10, 2003), aff’d, 2003 Del. LEXIS 624 (Del. Dec. 17, 2003) (ORDER) (“A majority shareholder has discretion as to when to sell his stock and to whom, a discretion that comes from the majority shareholder’s rights qua shareholder.  This is true even when a proposed transaction would result in the minority sharing in a control premium.”).

⁶ Mendel v. Carroll, 651 A.2d 297 (Del. Ch. 1994).

⁷ Orman v. Cullman, C.A. No. 18039, mem. op. (Del. Ch. Oct. 20, 2004).